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C04-Fundamentals of Business Economics: Sample Exam Paper
C04-Fundamentals of Business Economics: Sample Exam Paper
Question 1
Question 2
Question 3
The effects of low real interest rates include all of the following EXCEPT which ONE?
Question 4
In the circular flow model of the economy, the level of national income will always reach
equilibrium because:
Question 5
All of the following government policies would tend to raise national income over time
EXCEPT which ONE?
Question 6
Which ONE of the following would lead to a fall in the value of the multiplier?
Question 7
Which ONE of the following would lead a country’s balance of payments current account to
move towards a surplus?
Question 8
All of the following are benefits for a business from depreciation (reduction) in the rate of
exchange for the country’s currency EXCEPT which ONE?
Question 9
A slowdown in economic growth in the US would be transmitted to the rest of the world by all
EXCEPT which ONE of the following processes?
Question 10
A. The difference between the government’s receipts and its expenditure over the
period of a year.
B. The difference between the exports of goods and services and imports of goods and
services over the period of a year.
C. The surplus or deficit on a country’s international trade over a given period.
D. A statement of the economic transactions between residents of a country and the
rest of the world over a given period.
Question 11
Question 12
An expansionary fiscal policy would be most likely to reduce unemployment if the country
had:
Question 13
If a country were to join a free trade area, its business sector would gain because:
A. It could get tariff-free raw materials from countries inside the free trade area.
B. There would be exchange rate stability between the member countries.
C. Prices of competitors from countries not in the free trade area would rise.
D. There would be fewer barriers to establishing subsidiaries in other countries in the
free trade area.
Question 14
All of the following are reasons for trans-national companies locating production of a good in
more than one country except one. Which ONE is the EXCEPTION?
Question 15
All of the following are characteristics of a common market EXCEPT which ONE?
Question 16
Question 17
The process of globalisation leads to all of the following EXCEPT which ONE?
Question 18
Multinational companies locate production in more than one country for all of the following
reasons EXCEPT which ONE?
Question 19
Which of the following is the most appropriate for indicating long term shareholder wealth?
Question 20
(i) Employees
(ii) Shareholders
(iii) Management
(iv) Customer’s
(v) Suppliers
Question 21
Question 22
Not-for-profit organisations have all the following features except one, which ONE is the
EXCEPTION?
Question 23
All but one of the following are characteristics of all organisations. Which ONE is the not a
characteristic of all organisations?
Question 24
X plc has 1 million shares issued. It has an EPS figure of $0.10. X is planning a new
investment project which is expected to raise profits after tax by $50,000. This project will be
financed by an issue of an additional 250,000 shares. After the project is completed, the new
EPS will be:
A. $0.2
B. $0.12
C. $0.08
D. $0.15
Question 25
Which of the following might lead to a rise in earnings per share for a company?
Question 26
Which of the following are reasons why future income is usually valued less than current
income?
Question 27
If, in the long run, a business doubles all the inputs it uses, but total physical output less than
doubles, the business is experiencing:
A. Diminishing returns.
B. Decreasing returns to scale.
C. Price elasticity of demand of less than 1
D. Market saturation
Question 28
The minimum condition for a business to continue to operate in the short run is that:
Question 29
All of the following are internal economies of scale for a firm EXCEPT which ONE?
A. The firm is able to reduce administration costs per unit of output when it opens a
second production plant.
B. The firm can buy raw materials from other firms at lower prices when it buys in bulk.
C. TV advertising costs can be spread over a larger output.
D. Training costs are reduced when the firm can draw on the development of pool of
skilled labour in the region due to colleges setting up training courses for the industry.
Question 30
In order to remain in business in the short run, a firm’s revenue must be sufficient to cover:
Question 31
The initial fall for a business in the short run average cost per unit of its output is the result
of:
Question 32
Question 33
Question 34
Question 35
Question 36
Question 37
All of the following are example of the sources of internal economies of scale for a business
except one. Which ONE is the EXCEPTION?
Question 38
Which ONE of the following will tend to make the demand for a company’s product LESS
price elastic?
Question 39
In a market economy, prices perform all of the following functions EXCEPT which ONE?
Question 40
Which ONE of the following will produce the largest fluctuations in a market price?
Question 41
If the demand curves for Good A shifts to the left when the price of Good B rises, we may
conclude that:
Question 42
Which ONE of the following would lead the demand curve for a good to shift to the right?
Question 43
If a business currently sells 10,000 units of its product each month at $10 each unit and the
demand for its product has a price elasticity of -2·5, a rise in the price of the product to $11
will?
Question 44
If the government imposed a price for a good that was above the equilibrium price, the
consequence would be:
Question 45
If the government imposes a maximum price for a good that is below the equilibrium price,
the resulting market shortage will be greatest when:
Question 46
All of the following would shift the supply curve for a product to the right except one. Which
ONE is the EXCEPTION?
A. A government subsidy
B. An improvement in production techniques
C. Lower input prices
D. An indirect tax on the product
Question 47
If the production of a good involves an external social cost, the appropriate policy for the
government is to:
Question 48
A. By controlling sources of supply, the merged firms can prevent the entry of new firms
into the industry
B. There will be a lack of synergy between the merging companies
C. The merged firms will be unable to reduce costs
D. Consumers may suffer if the merged firm achieve market dominance
Question 49
A. A legal maximum price for a good always results in a shortage of the good.
B. A price fall for a good will lead to an increase in demand for that good.
C. A price fall for a good will always lead to a contraction in supply of the good.
D. An excess supply of a good arises when a legal minimum price is set below
equilibrium price.
Question 50
Which ONE of the following does NOT restrict the number of firms in an industry?
Question 51
Question 52
A. External costs.
B. External benefits.
C. An unequal income distribution.
D. The existence of monopolies.
Question 53
All of the following factors will lead to an imperfect allocation of resources EXCEPT which
ONE?
A. There are some production costs that are not borne by the producer.
B. Consumers only wish to buy a limited amount of the product.
C. There are spill over benefits in consumption.
D. Consumers have limited knowledge of market prices.
Question 54
Whenever government intervention prevents prices from reaching their equilibrium level, the
result will always include ALL of the following EXCEPT which ONE?
A. Shortages or surpluses.
B. Demand and supply not equal.
C. Reduced profits for producers.
D. Resources not allocated by price.
Question 55
The economic welfare case for governments increasing taxes on petrol to raise its real price
is that:
Question 56
Which ONE of the following would tend to increase the degree of monopoly power of a
company?
Question 57
Question 58
Which ONE of the following does NOT normally form part of the equity capital market?
A. Central bank.
B. Pension funds.
C. Retail banks.
D. Venture capitalists.
Question 59
All of the following statements about the monetary system are true EXCEPT which ONE?
Question 60
Question 61
All the following are sources of a short run lack of financial synchronisation for a business
except one. Which ONE is the EXCEPTION?
Question 62
A. Bank overdrafts
B. Debentures
C. Preference shares
D. Mortgages
Question 63
A. Venture Capital
B. Working Capital
C. Debentures
D. Gearing
Question 64
In their role as financial intermediaries, banks fulfil all of the following functions except one.
Which ONE is the EXCEPTION?
Question 65
A central bank has all of the following functions except one. Which ONE is the EXCEPTION?
Question 66
Question 67
Issued shared 1m
Question 68
A. Maturity
B. Base rate
C. Size of loan
D. Risk
Question 69
Question 70
Question 71
All the following contributed to the bank crisis of 2008/09 except one. Which ONE is the
EXCEPTION?
Question 72
A. A perfect market
B. Reinsurance
C. A future market
D. Underwriting
Question 73
All of the following would tend to raise the exchange rate (appreciate) for a country’s
currency except one. Which ONE is the EXCEPTION?
Question 74
Which one of the following is an advantage for a country adopting a flexible exchange rate
system regime?
Question 75
Which one of the following is not a benefit to a country from joining a single currency area?
C04 – Answers
C04 – Explanations
2. (answer: C) Supply side policy aimed at increasing the long term productive capacity
of an economy. This is based on the macroeconomic argument that economic
growth can be most effectively created by lowering barriers for people to produce
(supply) goods and services, such as lowering income tax and capital gains tax rates,
and by allowing greater flexibility by reducing regulation. As a result, consumers will
benefit from a greater supply of goods and services at lower prices.
4. (answer: B) The circular flow of income and expenditure model describes the
reciprocal circulation of income between inter-dependant entities of firms
(producers) and households (consumers) in an economy. With government and
international trade (four-sector model), injections into an economy are government
spending (G), investments (I) and exports (X), whereas the withdrawals from
economy are taxation (T), savings (S) and imports (M. National income will reach an
equilibrium when G + I + X = T + S + M.
5. (answer: D) National income is the total value a country’s final output of all new
goods and services produced in one year. National income can be increased by
enhancing the productive capacity (increase in long run aggregate supply - LRAS) and
/ or by increasing aggregate monetary demand (AMD). Better infrastructure such as
transport, information technology etc (option A) and trained workforce (option C)
will enhance the productive capacity of an economy, shifting the long run aggregate
supply curve outwards. Increased consumer expenditure (option B) will increase the
level of AMD. With more savings (option D) there will be less consumption, thus the
level of AMD will fall. [AMD = C+I+G+ (X-M)].
6. (answer: A) According to Keynesian economic theory, any injection into the economy
via investment capital (I), government spending (G) or exports (X) will result in a
proportional increase in overall national income. Decrease in MPC (marginal
propensity to consume) as in option A means, increase in the MPS (marginal
propensity to save). According to the below formula, decrease in MPS will lead to a
fall in the value of multiplier.
7. (answer: C) Balance of payments (BoP) current account records inflows and outflows
of funds into / out of a given economy due to international trade of goods and
services. If inflows exceed outflows, it will be in surplus. It will be in deficit if there is
a net outflow. Increase in foreign tourism into the country (option C) will result in
inflows of funds. Capital transactions between a given county and the rest of the
world (option B) are recorded in the BoP capital account, hence no impact on the
BoP current account. Government tax receipts (option D) is flow of funds within an
economy, and hence no impact on BOP.
11. (answer A) Inflation occurs when the general price level increase in an economy, and
as a result the buying power of money declines. This means, borrowers / debtors
12. (answer A) an expansionary fiscal policy involves reducing tax and / or increasing
government expenses, in order to boost the level of aggregate demand. This will
result in higher consumer expenditure and increased demand for goods and services.
Demand for labour is derived from the demand for goods and services, but if the
consumers tend to spend their increased income on imported goods and services, it
will not create employment opportunities within the economy.
13. (answer A) A free-trade area is a trade bloc whose member countries have signed a
free-trade agreement, which eliminates tariffs, import quotas and preferences on
most (if not all) goods and services traded between them. Therefore, firms in a free-
trade area will be able to import raw materials without paying tariff from the
member countries (option A). Exchange rate stability occurs when two or more
countries share a common currency or decides to peg their exchange rates (option
B).
14. (answer C) Trans-national companies register in more than one country or have their
operations in more than one country (e.g. design in Italy, produce in Sri Lanka,
finance / IT in Philippines). The operations are spread in different countries for
variety of reasons including options A, B and D. To obtain economies of scale in
production (in order to reduce the long run average cost), firms need to expand the
output, and need not necessarily operate from different countries.
15. (answer B) Free-trade area (refer Question 13) is also referred to as common market.
The individual countries can decide on taxation independently.
16. (answer C) Terms of trade ToT) is the ratio of quantities of domestic goods that a
country must give up to obtain a unit of imported goods. A rise in the prices of
exports with the prices of imports unchanged indicates a rise in the terms of trade
because it will now take fewer exports to purchase the same quantity of imports.
However, globalisation will not lead to improvement in ToT for all trading partners.
17. (answer B) is the process of international integration arising from the interchange of
products, ideas, world views and other aspects of national cultures. Therefore,
globalisation will increase interdependence of national economies.
18. (answer D) a company may continue to produce in the same country, but sell in
more than country to increase its market share.
19. (answer C) An important aspect of EPS is that it ignores the capital required to
generate the earnings (net income). Two companies could generate the same EPS,
but one could do so with less equity (investment) - that company would be more
efficient at using its capital to generate income and, all other things being equal
would be a "better" company. Therefore, EPS is the most appropriate for assessing
the long term wealth of shareholders.
21. (answer D) An organisation that exists for any reason (e.g. educational or charitable
reasons) other than for profit where its owners or trustees do not benefit financially. Surplus
revenues (if any) will be retained to achieve its goals.
23. (answer C) An organisation is a social entity that has a collective goal and is linked to the
external environment. There are a variety of legal types of organizations, including public
corporations, governments, non-government organisations, armed forces, charities,
partnerships, limited and unlimited liability companies, cooperatives, universities etc, some
of which need not / do not compete with other organisations (e.g. armed forces).
24. (answer B) EPS = Profit after tax and preference dividends/ No. of equity share in
issue.
0.01 x 1,000,000 = Original profit after tax = 100,000
New EPS = (100,000 + 50,000) /(1,000,000+ 250,000) = 0.12
25. (answer D) EPS = Profit / Number of shares (very basic formula). Therefore, reduced
profit due to increase in corporation tax (option A) and issue of new shares (option
B) will reduce the EPS. A fall in interest rate (option D) will increase the profit,
increasing EPS.
26. (answer D) Future income isn’t affected by the change of interest rate, although
lower interest rate may lead to inflation as more people are able to borrow money
and spend more. Higher interest rate, in contrast, is likely to reduce inflation and
will not cause future income to worthless.
28. (answer A) in the short term, the price needs to cover at least average variable cost.
29. (answer D) Internal economies of scale occur when a firm expands its output and as
a result the long run average cost falls, due to various reasons such as:
- fixed costs being shared amongst more output (option A and C);
- bulk purchasing enables trade discounts (Option B).
External economies of scale occur when an industry expands so that all firms in the
industry are befitted with reduced long run average cost (option D).
31. (answer C) Short run is a time period that is long enough to change only variable
inputs, and not fixed inputs. Therefore, in the short run, fixed costs remain
unchanged. A larger output in the short term means that the fixed cost can be
spread amongst larger output, hence short run average cost falls (despite, average
variable cost is assumed remain intact)
32. (answer B) Profit maximising output (where MR = MC) of a firm is called the
equilibrium of the firm. Up to equilibrium, MR > MC and therefore with each
additional output produced / sold, total profit increases. Beyond equilibrium, MC >
MR and as a result total profit will start falling with each additional output produced
/ sold. Therefore, for a firm to record the highest profit, it needs to produce an out
where MR = MC.
34. (answer A) For a firm to break even its total cost (TC) must equal to total revenue
(TCR). Assuming that a firm sells all output it produces, its TR = TC, when average
cost is same as average revenue (price).
35. (answer B) Profit = TR – TC and therefore, highest profit will be recorded when the
gap between TR and TC is the greatest.
36. (answer A) All typical business organisations aim for highest possible profit. The
optimal level of output is therefore the output that generates maximum profit.
39. (answer B) In a market economy, resources are allocated amongst competing uses
based via market mechanism (interaction of demand and supply). The economic
behaviour of both consumers and producers are influenced by price in a market
economy (e.g. at high prices, consumers tend to demand less). One main weakness
of market mechanism is that it leads to unfair allocation of income. For instance,
only those who have marketable resources may produce and earn an income.
40. (answer B) Obviously, large shift in supply or demand create the largest price
change, hence option D can be opted out. When demand is perfectly price elastic,
any quantity is demanded at a given price, so option C can be opted out. For a given
change in quantity demanded the largest price change can be expected when the
demand is inelastic, hence option A can be opted out.
41. (answer C) leftward shit of demand curve for Good A corresponds to reduction in
demand due any factor other than price of Good A (in this case, due to rise in price
of Good B). An inverse relationship between price and quantity demanded can be
seen for complementary goods (which are usually bought / used together)
42. (answer A) Rightward shift of the demand curve corresponds to increase in demand,
due to any factor other than price of the same commodity. When consumer income
rises, demand for normal goods increase, shown by rightward shift of demand curve.
44. (answer C) At the equilibrium price quantity demanded = quantity supplied. Increase
in price will contract demand and expand supply, leading to market surplus.
45. (answer B) Market shortage occurs when demand exceeds supply. For a given
reduction in price, a greater proportionate expansion in demand and contraction of
supply can be expected when the demand and supply is price elastic.
46. (answer D) Rightward shift of the supply curve corresponds to increase in supply,
due to any factor other than price of the same commodity. An indirect tax on the
product is shown by leftward shift of the supply curve due to increase in costs.
47. (answer B) An externality is a cost or benefit which results from an activity or transaction
and which affects an otherwise uninvolved party who did not choose to incur that cost or
benefit. An example for an external cost is air pollution caused by manufacturing activities,
that impose health and clean-up costs on the whole society. An indirect tax imposed by the
government will add to the costs of the producer, thereby reduction in activity is
theoretically expected.
48. (answer D) Horizontal merger occurs when two (or more) firms in the same industry
and at the same stage of production integrate (e.g. two car manufacturers). The
merged firm will be able to exploit consumers due the size, so governments tend to
discourage horizontal mergers.
49. (answer C) When the demand is perfectly elastic (horizontal demand curve), at a
legal maximum price (lower than equilibrium price), demand = supply (option A,
watch the word ‘always’!). A fall in price will expand (not increase) the quantity
demanded (option B). At a price below equilibrium price, there will be excess
demand due to expansion of demand and contraction of supply (option D).
50. (answer A) Options B, C, D high level of product differentiation are examples of entry
barriers which makes firms difficult to enter into a given market. #
52. (answer C) Market failure is a concept within economic theory describing when the
allocation of resources by market mechanism (demand and supply) is inefficient or
imperfect. An unequal income distribution is a consequence (not a source) of market failure.
56. (answer C) Fall in cross price elasticity of demand means the low level of
substitutability of the products, which gives a firm monopoly power. Ending of
patents (option A) and diversification into wider product range (option D) will reduce
monopoly power. Increase in excess profits (option B) is a consequence of monopoly
power, and not a cause.
57. (answer A) Money market assists businesses and governments to raise short term
capital in order to maintain the required level of liquidity.
58. (answer D) Central Bank is the banker to commercial banks, and banker to the
government, and hence is not part of the equity capital market.
59. (answer D) Liquidity is the ability to convert assets into means of exchange without
delay and loss of face value. Illiquid assets earn higher rate of return as
compensation for the loss of liquidity. Therefore, there is an inverse relationship
between level of liquidity and the rate of return.
60. (answer B) The key word to note in the question is ‘finance’ – an immediate measure
to bridge the gap between tax receipts and government expenditure. Options A, C
and D suggest medium or long term measures to address the problem.
61. (answer C) Financing capital equipment belongs to long term (not short term)
financial management.
62. (answer A) Bank overdrafts are usually a tool to support short term lack of financial
synchronisation.
63. (answer A) Venture capitalist specialise in funding high risk business projects /
enterprises, usually for a higher rate of return (e.g. high-tech business start ups)
64. (answer A) Financial intermediaries link surplus units (lenders / creditors) and deficit
units (borrowers / debtors). Banks offer cheque books for current account holders as
a safer / reliable means to engage in financial transactions. Aggregation (option B) is
where banks accept deposits of varied amounts and lend in lump-sum. Financial
synchronisation (option B) takes place when banks lend short term using depositors’
money. Maturity transformation (option D) refers to banks accepting deposits for
varied time periods and lends money for varied time periods.
65. (answer B) Central bank is the banker to the government (not the banker to
commercial organisation).
66. (answer 3.2%) Running yield = annual interest/ current market value
Annual interest = norminal value x coupon rate = 1000 x 4% = 40
Running yield = 40/ 1250 = 3.2%
67. (answer 12.5%) Dividend yield = dividend per share / price per share = 0.15/ 1.20 =
12.5%
68. (answer D) Creditors lend money to those who have a likelihood of returning it at the
end of agreed maturity period. However, debtors may face financial difficulties and
may not repay. Further, inflation reduces the value of money (what money could
buy) – all adds up to risk. Interest is charged to compensate this risk.
69. (answer $8,000) The credit multiplier of the bank is (1/ cash retention ratio = 1/
0.125) 8 times. Therefore, the additional cash deposit of $$1,000 will finally rise by 8
times. This is called ‘credit-creation’ by banks that practice ‘fractional reserve
banking system where a fraction of the deposit (in this case 12.5%) is retained and
the rest is advanced to borrowers with each new deposit it receives.
71. (answer D) If banks hold more capital than its liabilities, banks will be more
financially stable. The 2008/09 banks crisis was in fact caused by banks not having
enough capital relative to their liabilities.
72. (answer C) In forward exchange markets, lenders (banks) and borrowers (businesses)
contract to buy / sell foreign currency at a future date, at a pre-determined
exchange rate.
73. (answer C) Exchange rate is determined by the market forces – demand for (by
foreigners) and supply of (by residents) a given currency. Fall in domestic interest
rate is expected to reduce the demand for the domestic currency due to low returns.
Reduction in demand for the currency will reduce the exchange rate (depreciation).
74. (answer D) In a flexible exchange rate system, the exchange rate is determined by
the free play of demand for and supply of a given currency, without government
intervention.
75. (answer B) In a single currency area, the member countries collectives decide the
interest rate for all member countries, but there is no assurance that the interest
rate will always be low.